Outsourcing Best Practices
Copyright 2021, Faulkner Information Services. All Rights
Publication Date: 2107
Report Type: TUTORIAL
Each year, organizations spend
billions of dollars on outsourcing. Outsourcing, simply put, is sending work outside a company to a third party. Organizations typically outsource non-core processes or services that are
important to the day-to-day operation of the business but are not the core
competencies for which the business was developed. Outsourcing has many pitfalls, however, and
this report makes a series of recommendations on doing it successfully.
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Outsourcing, simply put, is sending work outside a company to a third party.
Organizations typically outsource non-core processes or services that are
important to the day-to-day operation of the business but are not the core
competencies for which the business was developed. Outsourced work can range
from IT processes, to Software as a Service (SaaS), to
customer service. The success of outsourcing depends heavily on the
relationship skills of the third party. Moreover, the location of the third
party involved is extremely important in assessing the best
outsourcing partner. Onshore, nearshore, and offshore
locations each have advantages and disadvantages that an enterprise must weigh
in designing its outsourcing plan. No matter which location is chosen, a local
liaison from the third party should be required.
It is also vital not to focus
only on short-term cost-cutting measures. For outsourcing to be successful, it
must align with long-term corporate or organizational strategy, be evangelized properly to
minimize domestic and internal objections, and have a local presence for
purchasing. The best outsourcing relationships can lead not only
to cost effectiveness but to improved core competencies and overall
growth as well.
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Outsourcing is sending work
outside a company, government agency, or other organization to a third party. It is generally a long-term,
results-oriented relationship. With a good partnership in place, outsourcing
can yield significant cost reductions. Although outsourcing usually refers
to business processes, it can also involve infrastructure, skilled
resources, or applications. Outsourcing was initially an Information Technology
(IT) strategy and ranged from Help Desk, Security, or Disaster Recovery to the
outsourcing of all IT management to a major vendor such as Accenture or HP
has since expanded to areas beyond this IT functionality, including finance, telemarketing,
and customer service centers.
In the last few years,
outsourcing has increasingly become synonymous in the US with the replacement of
internal staff with overseas staff, where salaries are significantly lower. Although it has been viewed with suspicion and anger
domestically during times of economic downturn, outsourcing is currently
experiencing a kind of renaissance, especially if seen and marketed as a way to
jumpstart a sagging business, create cost savings that can be pushed to the
consumer, and allow employees to focus on core
competencies to promote overall economic growth.
Examples of Outsourced Processes and Services
Some examples of the more commonly-outsourced
processes and services include:
- IT management
- Web development
- Security services
- Customer service
- Technical support
- Software as a Service (SaaS)
- Cloud computing services
Onshore, Nearshore, or Offshore?
Location is a huge factor
in the decision to outsource, and each location has its advantages and disadvantages,
as shown in Table 1. Onshore refers to domestic outsourcing; nearshore refers to outsourcing in the same geographic
region as the hiring company (such as Canada or Mexico for the US); and
offshore refers to outsourcing to a distant country (such as India, in the case
of the US). No matter which location is chosen, a local liaison from the
third party should be required.
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Organizations need to focus on
their core competencies in order to succeed. Outsourcing non-core processes and services
should theoretically enable enterprises to pay more attention to what they do
best. For example, wireless carriers excel at offering wireless telephone
service; they are not customer support organizations. Shipping companies do a
good job at moving packages, but they may not have the human or capital
resources to manage their IT infrastructure. Non-core business
processes are still critical parts of doing business, however. Regardless of the type of
work being outsourced, or whether an organization is a first-timer or a
seasoned outsourcing veteran, organizations should carefully evaluate and select
the right partner for their needs.
A strong outsourcing
partner can perform non-core responsibilities professionally and efficiently, following
best practices that have been honed over years of experience. Without
due diligence on the part of the hiring entity, however, outsourcing relationships can
be doomed to failure. Some of the potential pitfalls include:
- Inaccurate resource volumes. According to Alsbridge, a global consulting firm, "making
sure that the base volumes are correct for the life of the contract will ensure
accurate pricing and minimize contract adjustments due to ‘change’." Consider an IT help desk, for example. Understanding the number (and type)
of calls typically received is essential to characterizing and quantifying the
workload to be outsourced. Get this data wrong and the outsourcing deal is
probably doomed to failure (or premature renegotiation).1
- Absence of appropriate dead bands. A
"dead band" is a plus or minus variance from a baseline volume that
has been agreed upon as financially included in the outsourcing contract. It reflects the
reality that volume figures are seldom constant. Again, using the help
desk example, a baseline volume for calls might be 1,000 per month. If the dead band is 5 percent, then the outsourcer may be expected to handle as
many as 1,050 calls in a given month without additional compensation. Conversely, if the call volume drops to 950 in a given month, the outsourcer
still receives the same 1,000-call-based fee; in other words, the client is not
entitled to a rebate. The goal is selecting a dead band value in which:
(1) the variance is small; (2) the variance is seldom, if ever, exceeded (either
plus or minus); and (3) the number of plus variances over a given period is
roughly equal to the number of minus variances.2
- Narrow focus only on saving
Outsourcing is an opportunity to reduce costs, but cost is not king.
Companies who go through an RFP process to evaluate potential partners
should not weigh their evaluation too heavily toward cost considerations.
Instead, companies should carefully balance cost against other important
factors such as experience, technology infrastructure, quality, and
references. The old adage "you get what you pay for" does apply.
Hidden and soft costs. In assessing the potential cost
savings of outsourcing, so-called hidden costs must be considered as well.
While labor costs may be lowest if an offshore outsourcing vendor is
selected, communication costs may be highest. Moreover, managing from a
distance may also incur larger outlays of cash. Soft costs, such as low
morale, may also be a factor. If employees fear layoffs as a
result of outsourcing, they may choose to leave the company and expertise
in core competencies may be lost – a costly potential outcome that needs
to be taken into consideration.
Siloed strategies. The outsourcing strategy should
align with the overall corporate strategy to ensure that the outsourcing
model is sustainable and can grow with the company. Outsourcing needs a
corporate governance model and should be able to demonstrate value to the
business. If the outsourcing strategy is siloed,
then there is no corporate oversight and problems will occur.
Lack of internal education and
external evangelization on outsourcing strategy. To maintain morale and retain
employees in a business that chooses to outsource, an education campaign
should be launched so that employees know the strategy behind the
decision. In addition, the business should launch an informative PR
campaign to educate consumers that focusing on core competencies will
result in improving the domestic economy as the business succeeds.
Perception is key.
Lack of requirements
gathering. Up-front, businesses should work with the third party to
for the relationship, and document them in writing. Companies who
outsource should also work with the third party to establish a "train
the trainer" program, so the outsourcer can adequately train its
agents for continuity with their own core values.
communication/collaboration. Lack of communication is another pitfall for
outsourcing programs. Businesses should be in constant communication with
their outsourcing partners, and they should frequently calibrate
performance against key indicators. If there is a problem, it
should be communicated immediately instead of potentially lingering and
spreading. A good outsourcing partner will designate a single point of
contact – ideally a local contact – for any issues that may arise.
- Lack of control, with the third
party managing toward its own goals rather than quality. Businesses that make the
decision to outsource must carefully select a vendor who will keep the
clients’ strategic goals in mind instead of managing the operations
focusing on their own profit margins. Businesses should work with the
vendor during strategic planning and implementation (if applicable) to
ensure that there is a constant focus on the correct goals and that
quality is maintained.
- Sustainability during global health emergencies. This is a
potential pitfall that has only recently come to the forefront during the
COVID-19 pandemic. Companies moving any vital part of their operations to
another nation must deal with not only the possibility of a health crisis in
that nation, but also with the fallout of traveling to and from that country in
the event of a global pandemic. Given the constantly shifting tapestry of travel
bans, local lockdowns, and varying health and safety guidelines, this could
quickly become a nightmare capable of stifling a multi-national operation. While
COVID-19's impact is, for now, an unprecedented circumstance, a similar event is,
unfortunately, always possible
in the future.
Technologies, which specializes in developing SaaS (Software as a Service) solutions
– a form of
outsourcing – cautions organizations that malfunctioning "insourced" systems
will likely fail as readily as outsourced systems. In a blog posting, Neev
declared: "Clean up before you outsource. Companies tend to dump their problems on outsourcers, and then are surprised a
bad result ensues. If the company couldnâ€™t get the systems right, how it can it
expect the outsourcer to do it? Itâ€™s actually harder for the outsourcer because
they donâ€™t have your history, culture, and business context when trying to
decide what is ‘right’. Likewise, deploy new systems yourself, then
outsource to someone else to operate and maintain."3
In that spirit, before an organization considers outsourcing any "property"
(e.g., system, process, function), the organization should conduct a thorough
operational analysis to determine if the property is presently performing to
expectations and can, therefore, be outsourced. Ideally, this analysis
should be led by a third-party consulting organization familiar with outsourcing
dynamics. In addition to their independence and expertise, the inclusion
of a third-party will help demonstrate whether the potential outsourced property
is properly documented. Poor documentation is a key contributing factor to
poor outsourcer performance.
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When pitching an outsourcing deal, the proponents
in an organization must be
authentic and outline the performance extremes. Analyst Michael Alfonsi
advises the following:
- "Know the best and worst case
scenarios. This awareness of not only the most likely results but also
the best-case and worst-case scenarios is a crucial element in creating a
world-class business case that is respected, objective, and compelling. With this
information, CEOs can more easily determine whether the entire solution (or even
a single component) is worth the full investment, even if all worst-case
scenarios actually happen.
- "Figure out the risk of no
investment. Often overlooked, but just as critical in developing a
great outsourcing business case, is the ‘risk of no investment’ outcome. Speak
up! Demand to consider the risk of no investment. If the company doesnâ€™t make
this investment, what could happen to the companyâ€™s bottom line? Could the
company lose customers? Market share? Could it avoid some future costs if it
made the investment today?"4
According to analyst Sunny Gupta, a large
percentage of customers (more than 30 percent in one case) may be "leaving money
on the table because of ineffective management of IT outsourcing contracts." As Gupta explains: "Traditional contract pricing typically includes a
fixed fee for a contracted volume of services, with variation on fees for
volumes above or below those target thresholds. Additional resources required
are known as ARCs. Credits for reductions in services provided or resources
consumed are called RRCs (pronounced Rooks). This ARC/RRC methodology was
designed to account for service/resource fluctuations, but when customers lack
visibility into the processes that determine ARCs and RRCs, they lose
opportunities to identify how best to utilize the services the vendor provides."5
Like consumer cell phone or cable bills,
outsourcing customers must understand – and scrutinize – their outsourcing
charges to prevent escalating costs and a lower-than-expected return on their
Supplier Portfolio Strategy
Depending on their needs, organizations often engage in multiple outsourcing
arrangements. According to analyst David Miller, one useful approach to
managing multiple outsourcing firms is the "supplier portfolio strategy." The key to this model is:
- "Minimizing the number of relationships. The
fewer the number of supplier relationships the better as long as all the
companyâ€™s needs are met.
- "[Developing a] degree of redundancy. The degree to
which a supplier selected for one outsourced effort can provide support in
another outsourced effort should the need arise.
- "[Determining a supplier’s] flexibility
[to meet] future needs. The
supplierâ€™s ability and interest in offering additional services in the
future by expanding into new areas or by customizing its offerings to meet
the needs of the organization.
"With this strategy, suppliers need to be
carefully chosen. As the organization continues to expand its outsourcing
efforts, they must also contemplate the impact adding a new supplier has on the
overall supplier landscape."6
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Outsourcing best practices are the strategies, activities, and approaches
that have been proven through research and experience to be most effective in
improving the success rate and quality of outsourcing initiatives. The following
are some of the most effective outsourcing best practices (BP).
BP 1. Perform requirements gathering and analysis. Do not rely
solely on a third party to determine requirements, because it will be focused on its
own bottom line. Define both business and technical requirements in specific
BP 2. Pay particular attention to
cybersecurity. Analyst Stephanie Overby reports that according to Paul
Roy, a partner at legal services provider Mayer Brown, the key contractual
provisions to mitigate cyber risk are:
The security standards required of the vendor
Restrictions on subcontracting
Employee related protections, such as
background checks and training
Security incident reporting and investigation
Data retention and use restrictions
Customer data access rights
Vendor liability for cyber incidents7
BP 3. Issue an RFP to find the best
third-party vendor. In fact, have a short list of third parties, but do
not limit the request to these. Evaluate all responses in terms of both immediate,
hard cost-cutting benefits and long-term, soft benefits such as being
able to focus on core competencies.
BP 4. Ensure that the outsourcing
strategy is in line with the overall corporate strategy.
BP 5. If the work is being performed
outside the US, consider a provision that addresses fluctuations in the
exchange rate. Many third parties will include contract provisions by
which they will absorb changes in the exchange rate to a certain point.
BP 6. Clearly define success and stipulate
the penalties for failure to achieve milestones. Third parties should
offer and adhere to Service Level Agreements (SLAs). Make
sure that the final
and covers availability of services, performance, and support.
BP 7. If possible, when outsourcing
an IT project, pursue an "agile development" philosophy, which features multiple
development iterations, frequent deliverables, and constant communication.
Importantly, testing is performed concurrently with development.8
BP 8. Insist on transparency and
oversight. Businesses that are outsourcing should require partners to
provide regular status updates and reports.
BP 9. To mitigate internal employee
resistance, let employees know what is happening and communicate with them
regularly. Consider retention bonuses for key individuals.
BP 10. Hold a kickoff meeting to get
all the key outsourcing team members, clients, and stakeholders together.
Use the meeting to ensure everyone has the same understanding of the
agreement and their roles and responsibilities; build consensus and
teamwork through collective planning; discuss how communications, risks,
issues, and change requests will be handled; and identify any items that
require immediate follow up.
BP 11. Ensure that the third party provides
a single point of contact and local presence to minimize miscommunication
and optimize quick response to issues.
BP 12. Develop an exit strategy to be used if the
relationship is not working or the third party goes under. Include estimates for
legal issues and fees, as well as logistical issues, such as the retrieval of
proprietary systems, applications, and data.
The best outsourcing relationships can
lead not only to cost efficiencies but improved core competencies and
overall, long-term growth.
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1 "Keys to Driving a Successful Outsourcing Contract."
2 Ibid. p. 5.
3 "IT Outsourcing Best Practices!"
Neev Technologies. February 25, 2013.
4 Michael J. Alfonsi. "Twelve Best Practices to Create a World-Class Outsourcing Case."
Outsourcing Center. January 8, 2013.
5 Sunny Gupta. "IT Outsourcing: What You Donâ€™t Know Can Cost You."
CFO. June 13, 2012.
6 David Miller. "Managing Multiple Outsourcing Relationships: Best Practices."
CustomerThink Corporation (blog). September 16, 2014.
7 Stephanie Overby. "How to
into Outsourcing Contracts." CXO Media. April 6, 2016.
8 Anna Garland. "10 Best Practices
for Outsourcing Software Projects in 2016." Ignite Ltd.
August 12, 2015.
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